I read the "PRINCIPAL INVESTMENT STRATEGIES" section of the Large Cap Growth Fund. It does not shed any light at all on how/why this fund is different.

1) How is this Large Cap Growth Fund different from say a Vanguard S&P500 Growth (Style) fund ? How different is this going to be from a vanilla S&P500 index fund ?2) Isn't it well known that "small cap growth" is the black hole of investing ? Why bother with Small Cap Growth Funds ?

At least a quick read of the prospectus doesn't tell me that this is GARP, where high valuation equities are weeded out.

Its funny how DFA is becoming more active (that is, selective), albeit at low costs and using defined rules. Research (from my limited, casual viewing) appears to be moving toward security selection. That's fine, as long as the fees don't consume all this alpha laying around. Or maybe there's so little, people publish what was trade secret, after its lost its own excess return. Maybe they trickle out just enough to keep people in their funds, as needed.

Essentially, advocating for these new factors is advocating for open trade strategies (which require a plauseble risk story to be sustainable). That way you can know an active fund is doing something sensible. Looking at only returns doesn't give you enough to decide between managers (Larry's "don't confuse outcome with strategy").

I expect whether price setting or indexing pays better, to oscillate around an equilibrium, as pricing itself is priced. Is there a greek for that? Maybe one can rebalance between them.

Two of the standouts from the discussion were Vanguard Dividend Appreciation Index (VDAIX) and GMO Quality III (GQETX) (institutional). Both have performed very well and strikingly similarly within the Large Blend category over the past 3 and 5 years.

Ever since Granthams favoring "Quality", I've been tempted to set aside a quality allocation within our portfolio. Learning Fama's excitement for it adds that much more temptation.

OTOH, TSM includes significant % of "quality stocks" so I'm not convinced splitting out an allocation to quality (whether with DFA, Vanguard, or GMO) adds much incremental return?

In today's quatitative drive to find "factors" that define stock prices, every alpha is eventually commoditized into a beta and every active strategy is eventually renamed as a passive one. This is how active managers have been competing in an increasingly savy index world.

The question is where to draw the line between active and passive, quant and indexing. The water has become very, very muddy.

larryswedroe wrote:• Profitability, Investment and Average Returns by Eugene Fama and Kenneth French• The Other Side of Value: The Gross Profitability Premium by Robert Novy-MarxThese are the two papers you want to read if you're interested.

It's basically what I wrote about in that Buffett's Alpha paper.

I believe DFA will be incorporating this finding in lots of their funds, not just the four new ones.

The folks at AQR are also working on this factor for use in funds

Best wishesLarry

Thanks Larry. It will be interesting to see these new strategies do and how they stack up against the S&P 500 and the S&P 600 in actual realized returns.

I am surprised that the prospectuses make absolutely no mention of "High Quality, relatively low valuation" and so on. Maybe DFA will be adding more information on their website over time.

I hope this is not performance chasing on their part (given than growth has outperformed value handily in recent years).

Rules-based investments (quantitative, technical, fundamental strategies) are active strategies by definition even if they select exposure to certain (risk) "factors".

If behavioral or structural factors (agency problems) explain the historical performance of high-quality or low-volatility stocks, the alpha may not be sustainable if lots of money is invested in these strategies. You may add MSCI and SocGen to DFA:

The MSCI quality index methodology has three main components...“The indices are designed to reflect a quality growth investment strategy by identifying stocks with high scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage.”...MSCI’s move increases competition for French bank Société Générale, which earlier this year launched a quality income index.

Société Générale’s index includes between 25 and 75 global equities, selected according to their dividend yields and subject to an additional quantitative screening for profitability, leverage, liquidity and operating efficiency. The bank's exchange-traded fund (ETF) arm, Lyxor, has subsequently launched several ETFs on the bank’s index.

DFA prospectus:

In assessing expected profitability, the Advisor may consider different ratios, such as that of earnings or profits from operations relative to book value or assets

more profitable firms have higher expected returns, as do firms with higher Bt/Mt

The spreads in realized average returns are large, but the lion’s share is absorbed by the book-to-market ratio, with an assist from size. The average high minus low portfolio returns from cross-section regressions that use size and Bt/Mt to explain returns are 5% to 6% per year. Adding lagged profitability and growth to the regressions increases the average return spreads by less than 1% per year. When we add accruals to these regressions, the incremental return is again less than 1% per year, and most of this seems to be due to small growth stocks.

This may explain the negative alpha's on value indexes and positive alphas on growth indexes (in general) - if a 'profitability' variable were added to the three factor model then perhaps the alphas would all be closer to zero. It may also explain the more negative alphas on the Russell 2000 value index relative to the S&P 600 Value (for example). Russell includes both lower price-to-book and lower forecasted growth in their value index sorts, the latter may add to the negative alpha (lower return). S&P includes some measure of financial viablity in its S&P600 which may reduce the negative alpha (in relative terms). And selecting indexes with closest to zero alpha's may just mean those in which 'profitability' is not under or overweighted in index construction. In any event, the effect relative to price-to-book and size sorts seems relatively small (re: Fama-French quote above). FWIW - the value load on the GMO Quality Fund since inception has been -0.14 (suggesting considerations of profitability may lead to a 'growth' tilt). [my earlier take on high quality).

FDSo Dave what do smart people do> They look at the evidence and when they discover something has value in terms of explaining returns, a new insight, do they ignore it or incorporate that knowledge?The data here, having seen it, is very powerful. Should one ignore it, or change their views?I don't know about you but when I learn something new I change my opinions to incorporate that new knowledge.The question here IMO is do you ignore the evidence because there is not a good risk story (in fact it's the opposite IMO) or incorporate it?Here's one way to think about it. If it is going to go away because you think people will pounce on the idea and it will become crowded or arbitraged away then you should pounce on it immediately, not ignore it. You want to be the first on that bandwagon as prices of these stocks would take a one time jump.

Here's another thought. MOM has been known for decades, well publicized in the literature. But there's only a behavioral story so you would think once it's discovered it would disappear, but it hasn't happened. It appears human behavior is too hard to change and there are limits to arbitrage that seem to prevent it from disappearing. Even the most ardent of efficient market theorists, Fama, finally through in the towel and DFA began incorporating a negative MOM screen in 2003, after seeing what not doing so did to one of funds in 2002.

BTW-I'm surprised they called them growth funds as they are buying stocks with relatively high profitability relative to assets which just happen to be growth stocks.

The original link I provided was removed, so I am including it here. Sorry, but I apparently misunderstood the forum's policy about "naked" links. I thought the post was relatively self-explanatory; either way, I just thought DFA's launch of growth funds was interesting in the context of what they are traditionally known for (i.e., FF 3 factor)

Does anyone else find the below quote from the prospectus quite comical?

The Advisor may modify market capitalization weights after considering such factors as free float, momentum, trading strategies, liquidity management and other factors that the Advisor determines to be appropriate, given market conditions.

To me this means DFA can change the AA of the fund whenever and however they want based on their perceived "market conditions."

financialdaveProspectuses are written to give the fund manager flexibility to address almost any condition that might happen. Otherwise when you have an unusual/unanticipated situation (like financial crises, liquidity drying up, etc) the fund could be forced into trades that would be very expensive just in order to stick to the prospectus (like must keep market cap weighting exact).There is nothing "shady" here at all.Larry

Don't let the salesmen bamboozle you into thinking this isn't active. Of course all active strategies have (past) research to back them - that's the whole allure. Hedge funds don't pick stocks by feeling, they have complex quantitative screens based on historical patterns that they've discovered.

Now, that doesn't mean you can't believe in active funds (even Vanguard has Wellesley etc.), but don't imagine you're doing anything different than most people picking active funds because they think "THIS manager is better."

larryswedroe wrote:financialdaveProspectuses are written to give the fund manager flexibility to address almost any condition that might happen. Otherwise when you have an unusual/unanticipated situation (like financial crises, liquidity drying up, etc) the fund could be forced into trades that would be very expensive just in order to stick to the prospectus (like must keep market cap weighting exact).There is nothing "shady" here at all.Larry

I have to take exception here. If "read the prospectus" is to mean anything at all, it means "read the prospectus and believe what it says." It doesn't mean "check off the checkbox that says you've read it, but don't look over there, look over here at the shiny brochure. No, no, no, don't worry about the prospectus, it's just lawyer stuff, they would never really do anything like that. Pay no attention to the prospectus behind the curtain."

Nisiprius You can take all the exception you want, but that is how prospectuses are written.Now some people/funds use that large flexibility all the time--which is what active managers do. Like say PIMCO with its collateral for the TIPS fundNot the case here. Larry

BogletyWith investment grade, especially high investment grade, bonds you need far less diversification, and you have far less tracking error when do sampling. Almost all of the risks are INTEREST RATE, not credit. That is why it's so hard for active bond funds to outperform, far less differentiation say between Microsoft and Johnson &Johnson bonds than their stocks. So it's basically pretty much about costs (and of course turnover involves costs, especially at lower credits)

It tells me a lot about a group who thinks they have found the next "mouse trap."

I think the correct quote in this article should have been -- "We don't know exactly why it has worked, but it worked." Unless of course they own a time machine -- which would be something to invest in!

The other key here is "We don't know why.."

A very old saying is that if you don't know why some investment works (ie you can't understand it) you should not be investing in it.

I said it in the last thread on this, but I think it's worth reiterating.

P/E = (P/B) / (ROE)

You can see P/B as a proxy for what the academics call "value" and and ROE as a proxy for "quality." There is really nothing new with combining these two metrics. P/E is already a perfect distillation of the two metrics. Obviously you can further up on the income statement and the logic remains the same.

I guess I don't see what all of the fuss is about I think its a case of DFA kool-aid

Over the long run, these factors should come out on top, but they don't offer any magic to ward off events such as the financial crash or periodic bouts of underperformance, researchers contend.

This quote reminds me of a conversation I had with a DFA advisor a number of years ago -- when I asked him why my combination of index funds was outperforming his recommended portfolio, his only response was I probably needed to see what happens over a much longer time period like 50 years!

I'm cautiously optimistic about the profitability approach being bruited about in this thread, but I've had a look at the backtested growth fund returns, and basically they have the same return as the appropriate all-market market: small and large, international and domestic. The idea is to start with a growth index, which has an expected below-market return, then tweak it with a profitability screen to get back to the market return.

So, with higher expense, higher turnover, decreased diversification, but same return--possibly--as the market, why own it?

Answer = not.

So who are these funds for? Answer = institutional investors, mainly, who are mandated to own small and large growth.

With luck, adding a profitabilty screen to an all-market fund (DFA just came out with a US large-cap version of this) and applying the profitability screen to DFA's existing approaches (in the works) just might provide some excess returns. But the growth portfolios are not for savvy investors, small or institutional.

I'm cautiously optimistic about the profitability approach being bruited about in this thread, but I've had a look at the backtested growth fund returns, and basically they have the same return as the appropriate all-market market: small and large, international and domestic. The idea is to start with a growth index, which has an expected below-market return, then tweak it with a profitability screen to get back to the market return.

So, with higher expense, higher turnover, decreased diversification, but same return--possibly--as the market, why own it?

Answer = not.

So who are these funds for? Answer = institutional investors, mainly, who are mandated to own small and large growth.

With luck, adding a profitabilty screen to an all-market fund (DFA just came out with a US large-cap version of this) and applying the profitability screen to DFA's existing approaches (in the works) just might provide some excess returns. But the growth portfolios are not for savvy investors, small or institutional.

Bill

Bill

Thank you very much for this clear headed reply. The profitability factor has been addressed in a couple of other threads and I and others have posted our doubts there that this was worth it....but others have posted about how great this new factor would be to juice returns. It is good to hear your analysis. In addition, it seems to me that much like momentum, now that everyone knows about it, it is unclear the excess return won't be priced out of the market.

The discussions about the "new" factors mostly lead by Larry Swedroe has convinced me that I am not such a complete idiot for not being 100% indexed in my investments.

My first real investment was a taxable mutual fund, which I still own. My IRA investments were bank certificates of deposit. Later on, I started my workplace savings plan.

About 1988, a friend called me. He had gone into the brokerage business and wanted my account. He was at an office that had two Money Magazine All-Star Brokers who both were value investors. So my friend and a successor broker schooled me in value investing. I did this with individual stocks. So I invested in the "Value Premium".

I have never believed in the "cigar butt" definition of value investing. I have attempted to buy quality at a good price.

Somewhere along the line, I wanted more diversification and went to mutual funds in my workplace plan. My IRA was a brokerage IRA and was mostly individual stocks. So I opened an IRA at my favorite mutual fund company which had a lot of funds that emphasized earnings and price momentum. So I invested in the "Momentum Premium." The fund company later opened international, value, and real estate funds and I bought into all three. I had never heard of DFA and didn't realize REITs were a non-correlating asset to stocks but had similar returns. I bought because it seemed a smart diversification move. In my brokerage account, I bought a couple international value mutual funds.

My favorite mutual fund company looked for growing earnings and secondly price momentum. The theory was that the best companies in the world to invest in have earnings that grow at an increasing rate. Was this an attempt to capture the "quality" premium that Mr. Swedroe talks about?

Back at the Brokerage Account ranch, though I was a Value Investor, my first broker and his successors taught me to not only buy Value but to get good quality companies. Good companies with temporary problems that caused their price to be depressed. And my brokers all liked dividends. Getting paid while you wait. Plus I had the dividends to reinvest. So perhaps without the sophisticated screens that DFA has, I was trying to do what DFA is trying to do now.

At my favorite mutual fund company, I learned that their mid/small cap funds seemed to do better than their large cap funds. I sort of stumbled into the small cap premium. A couple of their mid cap growth stock funds gave me really good performance over the years, certainly better than their large cap cousins.

After my insurance company reviewed my portfolio, they said that I needed more small caps. So I bought an S&P 600 Small Cap Index ETF.

After learning about DFA, I de-emphasized the role of individual stocks in my brokerage account and started buying ETFs to get into asset classes that I felt I needed. Microcap, International mid/small cap, US Small Cap Value. I decided I needed more REITs, so I bought a REIT ETF as well. I started tilting to "small" and "value".

Later on I learned about indexing. So now I am indexing a bit more than 1/4 of my portfolio to cut costs and to assure a market return for that portion of my portfolio. My largest holding is a US Total Stock Market Index fund.

So I own individual stocks (mostly value and quality oriented), price and earnings momentum funds, value funds, ETF's trying to capture the "small and value" premiums, a Micro-Cap EFT attempting to capture a liquidity premium, and of course bond funds.

So after reading all these threads, I give myself an A for effort in attempting to capture the premiums that Mr. Swedroe talks about. Some of this did because it just made sense. But I didn't know that there was academic research to back these up. I went by the advice of people with experience and by what I learned in the markets.

Have I outperformed the market? Hard to say. My investments have performed about what one would expect. I track my returns on Quicken but it is hard to say exactly how my returns compare to the market indexes. My suspicion is that I am close. Maybe a bit over or a bit under.

So am I brilliant? Or am I the idiot that Shakespeare referred to when talking about "sound and fury, signifying nothing!?"

What I was trying to say is that these factors that Larry Swedroe talks about have been known in the investing world for some time.

The DFA research has refined and clarified beliefs held by many investors. Things that people believed from experience but couldn't quite put their finger on. They just knew that if they did certain things that their investments worked out.

What I am getting at is that the "factor" investing that Mr. Swedroe talks about is getting close to active management with lower costs.

Aren't retail mutual funds companies using stock screens to capture the same factors that the Academics are talking about? Is this really new or are we just better defining with greater precision what many of us had known all along?